Saving vs Investing: Factors to Consider
In the last two blog posts, I focused on saving and investing respectively. In this post, I will focus on the factors to consider in determining whether to save or invest.
When it comes to wealth building, both saving and investing are important. Saving involves setting aside money ( typically in a savings account) for future you. An example is saving for a vacation. Investing, on the other hand, is putting funds into assets with the expectation of growth over time. Examples include stocks, bonds, and real estate.
There are situations when you may prefer either savings or investment. The very first step to take in becoming financially independent is having an emergency fund. It is recommended to have three to six months of expenses as an emergency fund. If you ever lose your job temporarily or some unexpected expenses come up, you will not end up in debt. After setting aside an emergency fund, you may allocate your money to savings and investment depending on your financial situation.
When it comes to allocating money between saving and investment, the following must be considered.
· Inflation and interest rate: Inflation is a measure of how quickly prices increase over time. Have you ever bought an item and later you wanted to buy the same item again, but the price had gone up? That’s the effect of inflation. What many people don’t realize about saving is that for most savings accounts, the money they keep in their accounts is losing value. The national average APY for savings account as of March 18, 2024, according to the Federal Deposit Insurance Corp, is 0.47%. At the same time, the US inflation rate for March 2024 (12-month based) was 3.48%. Meanwhile, according to DQYDJ S&P 500 calculator, the annualized S&P 5oo return between 1971 and 2024 is 7.762%. So, when it comes to hedging against inflation, investing is a better choice.
· Risk: If you deposit your money in a bank insured by the Federal Deposit Insurance Corporation FDIC, your money is covered up to the $250,000 limit in the event of a bank failure. So, there is no risk associated with saving money. Investment, on the other hand, has associated risks. In the same way that the value of your investment can increase over time, you can also lose part or all your investment. Generally, the higher the risk associated with an investment, the higher the expected return. The opposite is also true. So, if you don’t mind taking risk, you can invest but if you are risk averse, you may want to save your money. The general rule is to not invest money you cannot afford to lose.
· Liquidity: Liquidity is the ability of an asset to be converted to cash. Savings is liquid. On the other hand, depending on the kind, an investment may not be readily and easily converted to cash. The general rule is to not invest the money you may need urgently.
· Fees: Many savings accounts come with a monthly maintenance fee and excessive withdrawal fees. You are only allowed to withdraw from the account six or less times in a month. Starting from the seventh withdrawal, the excessive withdrawal fee kicks in. There may be other fees apart from these two. However, some banks, especially online banks, have free savings accounts. So, it is important to read the fine print of fee schedules before signing up for a savings account. At the same time, investment, depending on the type, may come with its own associated fees. For example, many brokerage apps charge trade commission when you purchase or sell stocks on them although $0 commission trading platforms are becoming more common. So, in deciding between saving and investing, it is important to consider the fees associated with both.
· Time horizon: Saving is generally preferable for a short time horizon while investing is preferable for long time horizon.
The Bottom Line
Both savings and investments play essential roles in your personal finances. As highlighted earlier, both savings and investing have their pros and cons. So, it is important to find the right balance that works for your goals, risk tolerance, and time horizon. Ultimately, an approach that involves both saving and investing can go a long way in improving your financial wellbeing and give you financial security.